tv Bloomberg Real Yield Bloomberg October 27, 2018 2:00am-2:31am EDT
♪ jonathan: from new york city, i am jonathan ferro. this is "bloomberg real yield." ♪ jonathan: coming up, junk debt a shelter from the global equity market storm. the fed indicating a market correction will not be enough to shape policy. the optimism supported by strong u.s. gdp. they better than expected 3.5%. we begin with the riskiest part of fixed income, a basket of -- bastion of stability in a volatile world. >> credit conditions and lending standards remain extremely generous. >> what we have been saying a long time on credit is it is too extensive to buy but too early
to short. >> a basket of highly leveraged equities are underperforming. yet the fixed income credit markets are not that worried about it. it is a really interesting disconnect and quite unique. >> high yields should be compared to equities. certainly on a risk-adjusted basis, maybe even on an absolute basis, high yields are looking more attractive. >> if you see lending standards tightened and credit spreads widening on a sustained basis, you know you will create a feedback loop into equities and you are going to head into recession. we don't think that is a story for the next few quarters yet. >> the u.s. recession looks a long way away to me. you would normally see credit starting to weekend, starting to widen if we were starting to deteriorate in the underlying growth picture. that is not there at the moment. newthan: full has here in york -- full house here in new york city with me today.
joining me is rachel golder, marilyn watson, and robert tipp. rachel, i want to begin with you. and ask you the question of the central of that piece. equity markets all over the place. yet, the junkiest part of junk is doing ok. leveraged loans are doing ok. why? rachel: you could either assume that equity is the beginning of the end and credit would catch down with it, or this is a flash in the pan and there will be a recovery with equity. we believe there will be a recovery. that actually the fundamentals of the market and the economy are strong. you look at the underlying default rate, very benign and likely to be so for years to come. one of our strongest convictions is the energy recession of 2015-2016 really hit the reset button for corporate behavior for how the market was addressed, and gave the market a chance to heal. the quality of the market is not as dire as a lot of people have suggested. jonathan: you're not alone in
making that point that high-yield had its moment. do you share that view? marilyn: when you look at the high-yield market, there are strong technical reasons why it has performed very well. the lack of supply versus demand, still strong demand for yields. you continue to see that. we are seeing a shift. you are starting to see better valuations in europe, for example. particularly if you are using the fx components and converting it back to dollars, it is attractive now. i don't think it has had its day, but the fed continues to hike on the contingency. jonathan: robert? robert: it has been a sleeper outperformer this year. it is a good environment. it is a u.s. leaning market. the economy is doing well. while europe has been having its problems, emerging markets were getting hit, investment-grade has more downside than upside and high-yield was the sweet spot. the equity market was racing away. in the u.s. uniquely, relative to other countries, you have
steep correction in equities spilling over a bit. but i think to the extent that this recovery, this expansion, continues, they are likely to reemerge as a sweet spot. jonathan: it would be disingenuous of me to say credit has come out of this completely ok. we have seen spread widening in high-yield. the broader point is the outperformance has been the worst part of high-yield. the broader point, leveraged loans have remained resilient. to your point, if there are people watching right now worried about the equity market volatility and downdraft, is the message to them ultimately that credit is not one of doom and gloom around the corner? robert: i think leveraged is the hot area. that is the hot area where the value is not necessarily there. that is going to be the weak underbelly when we get to the next correction. in the meantime, technicals are strong there. it has gone from a wholesale cheap fixed income market in
credit from a couple of years ago, it is more of a bond pickers market. you have to be very selective, whether it is peripherals, high-yield, emerging markets. the most difficult to find, ig. jonathan: can i pick up on the point that technically the market is strong. why is it technically strong? robert: we have two experts here, but retail demand is very high. you have a fed rate hike environment. that has created a bulletproof technical for that market despite high issuance. jonathan: rachel, are the fundamentals strong? rachel: fundamentals are strong. the technical we need to mention also is the clo demand. clo's are issuing at a phenomenal click. they now represent over 50% of the holder base. it is important to look at this as a relatively stable pool of assets. they will not be forced sellers in the next recession. they came through the financial crisis in good shape. they actually generated good
returns. so i see the clo base as a stabilizer, but also the demand from the clo's has created a supply that is actually relatively unique. below-market has changed -- the loan market has changed materially. the percentage of the market that is loan only has doubled in size in the last couple of years. you have weaker covenants and it has drifted down in ratings quality. i'm not saying we do not like loans. they actually still like them in the view that rates are continuing up for the next couple of quarters. they will still be a go to investment asset class. jonathan: your point about them being loan only is important. there are a lot of people out there thinking they will be higher up in the capital structure. the problem is there will be nothing beneath them. what does this mean for recovery rates? a lot of people look at the historical analysis and say recovery rates are ok. they are good. is it a different market compared to 10 years ago? rachel: we expect it will be. you have entire structures composed of loans. there is no subordination or first loss piece beneath the loans.
if historically the loan recovery rate has been $.70 on the dollar, we would use the lower number. it is probably something around $.60 or below that. it also depends on how stressed the balance sheets are. we would say overall leverage is not excessive. it is not terribly worrying. but then we would look at the nature of the underlying cash flow and say a lot of add backs have been permitted to boost that number. if you looked at a more reliable cash flow number, these companies might be more leveraged. we think not only lower recoveries but also potentially more volatility. jonathan: this underlines how much homework you need to do right now. if you're piling into the space, how much homework do you need to be doing in leveraged loans at the moment? robert: exactly. those are the points. the demand is strong. the clo demand is strong. but you need a really robust credit team to go into every deal. if you have that, by the time we get to the next downturn and you
have been selective, you may have similar downside experience to high-yield. all things equal. but for those going in that are not doing that homework, it is not going to be pretty. jonathan: in terms of return profile at the moment, spreads for high-yield have been wider. do you anticipate high-yield delivering a little performance relative to leveraged loans? or will it still be in leveraged loans for you? robert: i think it will still be in high-yield. that is for a couple of reasons. the high-yield spreads are down 50 basis points on the index and rates are up. i think we are getting to the point where a few interest rate hikes down the road, the fed will be done and there will be some dropping of the long-term yields. the cycle is probably not over. in which case, spreads are in. the technical point on the high-yield will be the superior convexity. the loans get called away with cash when -- the loans get
called away when the spreads tighten. they will not participate in the interest rate rally. jonathan: you don't think we have seen post crisis heights in high-yield space? robert: i don't. i think i.t. is different. there are opportunities. when you adjust for everything, the spreads were incredibly tight earlier in the yield. it seems unlikely we will go back there. in high-yield, if the fed succeeds in not killing the economy and we have a moderation on forth, and this goes a few more years, i think the technicals could move the market quite a bit. jonathan: marilyn, do you share that view? marilyn: as we move forward in -- as we move forward and the fed continues to raise rates, i think one other aspect to be aware of is the change in the size of the ig market, and the triple b's space, how that has grown exponentially when you compare it to the double be space. as you get closer to recession or toward the end of the cycle, if you see downgrades from triple b into high yields it is a factor you need to consider as
well. jonathan: a final word on credit? marilyn: we have -- rachel: we had 7% yields in high-yield. i think there is a threshold that really matters to people. within the rate rise, we can see further spread compression. we would be buyers into the end of the year. the technicals and fundamentals are looking good. jonathan: a bullish group today. joining me alongside marilyn and robert. coming up on the program, the auction block. netflix dangling high yields to investors in a $2 billion junk-bond offering. that is coming up next. this is "bloomberg real yield." ♪
this is "bloomberg real yield." i want to head to the auction block now, where netflix was the headliner for the week in high-yield. the company sold more than $2 billion. they had to offer yields at the high end of the price expectation. the first time that has happened for one of the company's debt sales. elsewhere, u.s. debt investors are helping to finance the future of the wheat industry. it sold more than $2 billion of bonds to help boost its stake in canopy. weed grower spacex is said to be working with goldman sachs. they are raising $500 million of leveraged loans. spacex valuation has climbed to about $28 billion. this week, janet yellen joining the chorus of people concerned about the rise of leveraged loans. she said in an interview, i am worried about the systemic risk associated with these loans. there has been a huge deterioration in standards. covenants have been loosened in leveraged lending. it is a big issue she has chimed in on and many others have as well. still with me, rachel golder,
marilyn watson, and robert tipp. robert, to come to you, i raised that quote because i am wondering whether some current and former fed officials are trying to tell us something. the guiding light at the moment seems to be worries about financial assets and wobbles. robert: they are operating in a world of uncertainty. but they do know that what has ultimately has cost the average american, and even more than that, are the big downturns. the crashes, and the crashes have been caused by the bubbles. those are the ones where the bulk of society recovers slowly. instead of being very cautious. it was probably five years ago she was warning on biotech, right? i think it behooves them to kick the tires and see if anything rattles. but i think that is what will extend the expansion, not seeing the widespread access of
aggressive lending versus appreciated assets, the real estate bubble, or any gigantic sector bubble, you are not seeing that but they continue to raise rates. i think in the end, that is what will be very helpful. jonathan: that is the former fed chair. current fed officials, one of them warned this week about the leveraged loan market in a sort of emphatic way. the current fed chairman himself jay powell has talked about financial instabilities being the biggest risk. not so much inflation. marilyn, i'm trying to get my head around this. on a week where fed officials have come out one after one and basically said the equity market volatility will not force them to pull back on the rate path, i'm wondering what the guiding light is for them now. marliyn: that is the $1 million question. they made it clear they are not sure where the neutral rate is. the economy as we saw today with gdp numbers continues to do
incredibly well. we are seeing strong data from consumption data. but we are starting to see, though, the impact in the housing market and other rate sensitive sectors like the auto sectors. so we are starting to see where rate rises are having more of an impact now. i think, especially as we get into next year, and the committee has less of the consensus around two or three or four hikes next year. the question becomes, at what point do they pause and start to go on a meeting by meeting basis rather than consistent, gradual increase in rates? jonathan: we are seeing tensions start to emerge in a more material way, and that tension is between the market pricing, and where the fed is telling us the hikes will be. even this week, a slightly pricing where december will be, whether the hike comes through are not. i am wondering where the market is and where the federal reserve is and how the spread reconciles in next 12 months. rachel: the fed and the market have gotten much more closely
aligned in the last couple of months than they had been in the past. now it looks as though powell is trying to dial down the reliance on the forward guidance, trying to paint a steady picture going forward. we still think the fed put is there but it is deeply out of the money and you are seeing the strong economy with decent inflation but not an immediate threat of inflation breaking out to the upside. as we go into 2019, there are a number of other forces that will begin to push the fed's hand. we think the tax reform has been a tailwind for 12 months. that will begin to fade. trade is already beginning to cause supply-chain disruptions. as we look among other things at the difference between the performance of the equity market, which is been very weak, and the credit market, which is -- which has been somewhat
stronger, i think it relates to the expectation of slowing topline growth. you have slowing topline growth. if margins begin to erode, you will see leverage worsening. this is just one of the piece of the puzzle of tighter financial conditions, and that will influence the fed's hand. it is just not immediate. jonathan: you mentioned inflation. i think that is important. inflation expectations, are they starting to roll over a little bit? just looking at the five-year maturity, you start to see some signs of that happening. robert: today, you are seeing it. but it is surprising how little they have come down given how much energy has come off. the curve is incredibly flat, which suggests the market does not have a strong view about where it will be headed in the long-term. on the fed, when you look out a year or two, and the fiscal is fading, and presumably energy prices will crash and go horizontally, when they are at a neutral rate and the economy is doing well and there are not clear inflation pressures building, i think the onus will
rise for them because they will be going into possibly restrictive territory and hurting the economy when they are not sure they need to do it. jonathan: is it hurting the economy right now? robert: i don't think so. i think they have safely created room to cut so far. the economy has plowed through this. you are just beginning to see in new home sales, in particular, a correction which has extended a little bit further. there have been waves in the rise the last handful of years. this one is beginning to be longer than the ones before. your interest rate sensitive sectors are beginning to bite. they are thinking they have two or three more moves before they need to slow down. maybe they need to slow down a little sooner. jonathan: you are going to stick with me. in the markets this week, a check on where treasuries have been. twos, tens, and 30's. treasury yields shaping up as follows. treasuries receding a bit on the front end. down by 10 on a 10-year.
♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." it is time now for the final spread. coming up over the next week, we will have a pair of central bank rate decisions. one from the bank of england and the other from the bank of japan. we will get another round of earnings, of course. the brazilian election and the u.s. jobs report to close out the week next friday. payroll friday around the corner. still with me to discuss is rachel, maryland, and robert are still with me. speaking of blackrock, the front end has been a story, the repricing on treasuries.
are we getting to the point where we could be close to the peak? marliyn: we still like the front end of the curve. we think it might be from here pretty well anchored. if you continue to hold that, we think it is reasonably priced in now, the number of hikes you might have. the next move could be more of a steepening if the fed does indicate it will pull its rate hiking cycle. even if yields go up more, you are still cushioned. whereas further up the curve, there go to 10 or 30's, is no cushion. jonathan: walk us through why the next move could be a steep one. and what the catalyst will be for it. marliyn: if the fed announces it ause at some point, the market is not prepared for that. we have seen some movement and a
few signs the market is concerned, but it is not yet priced in the fed might act pause sooner rather than later. that potentially will raise rates in december but i think next year, the market will start to reassess its view of the rate hiking cycle. it will reassess its view of the u.s. in relation to europe and japan. you have seen the curve flattening most of the year. now we are seeing it steepen a little bit. it has been supported by pension investors, foreign investors. i think some of it has played through. also the fx hedging cost is so expensive, now you can see foreign investors going elsewhere and getting better yields. jonathan: it has been a big conviction trade for you. have you changed your view? robert: i think it has relocated a bit. the bond was a spectacular performer. part of that was the shift in issuance. the fear with trump coming in was they might extend and want
to do ultralong treasuries. instead, last year, they moved supply heavily to the front end curve. they have been pounding that and introducing new maturities on the front into the curve. bond has been a spectacular performer until lately. i think now the performance spot is between fives and 10's. at this point, it may be too early for 2's. if you look at the last rate hike cycle, they peaked with the last hike. if the last hike is going to be close to or above 3%, 2's may have some downside. at that point, you will probably be inverted. jonathan: we have to wrap it up with the rapid fire round. you know how this works. quick final questions with quick answers, if you can. will credit still lead equity going into the next downturn? yes or no? rachel: yes. marliyn: yes. robert: yes. jonathan: have we seen the post crisis hike on high-yield? rachel: yes.
marliyn: no. robert: i don't know. jonathan: is the fed put a thing of the past? rachel: no. marilyn: yes. robert: no. jonathan: interesting stuff. thank you for joining me over the last 30 minutes. my special thanks to marilyn, rachel, and robert. that is it for us this week. we will be back in new york same time, same place. friday, 1:00 in new york. 6:00 p.m. in london. for our audience worldwide, this was "bloomberg real yield." this is bloomberg tv. ♪
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